April 12, 2021
Article
As I have mentioned in articles before, contributing to a pension can be a great way to help build wealth, particularly due to the tax relief that is available to increase the contribution.
Here, I want to set out just how effective these tax savings can be for somebody where their income breaches the £100K threshold and they therefore start to lose their tax free personal allowance of £12,570. Where your income is between £100,000 and £125,140, you will pay an effective tax rate of 60%!
For example, let’s say that you earn £100K exactly and you receive and £10K bonus. Due to the loss of part of your personal allowance, you will only receive £4K of this bonus and £6K will go to HMRC in tax. To some, this will be outrageous. Especially as I have ignored the national insurance cost here, which will cost you another 2%!
This is where pension planning comes in. If you were to sacrifice that bonus of £10K in exchange for an employer pension contribution, or simply pay £8K net (£10K gross) into your pension fund, then you would preserve your personal allowance. This will enable you to get £10K into your pension fund at a net cost of just £4K after tax relief. The tax saving here is therefore £6K.
Let’s look at another example, where the salary is still £100K and the bonus is now £25K. If you take the bonus, you will receive roughly £10K in cash, ignoring national insurance. The other £15K will go to HMRC in tax.
If you were to sacrifice that bonus for a £25K employer pension contribution or pay £20K net (£25K gross) into your personal pension fund, you would be able to get £25K into your pension at a net cost of just £10K. The tax saving is therefore £15K.
If you or any of your family, friends and colleagues have income above £100,000, or any unused pension annual allowances, please give me a call to see whether you or they could benefit from some significant tax savings as a result of this kind of planning.
Great care needs to be taken if you are in some kind of defined benefit pension scheme where you are guaranteed a pension in retirement based upon your career earnings. Please get in touch with our Financial Planning Team if this is the case.